Thursday, June 24, 2010

Sonray Capital – another Australian broker failure

Sonray Capital failed a couple of days ago and the clients are likely to incur nasty losses. Strangely I first found out about this from US news sources. Only three weeks ago I wrote a letter to a blog reader who knew someone who worked at Sonray expressing my doubts about the organization.

For my global audience I should specify that Sonray commanded four-fifths of five-eights of not very much of the market. In no way is the failure of this broker a reflection of the economy. It is a failure – as if another one was needed – of Australian broker-dealer rules – or more precisely the lack of broker dealer rules.

The United States has strict rules which segregate client assets from broker assets. The broker can’t use client assets to fund their own business and there are limits on the extent to which client assets can be rehypothecated. In the UK those limits are thinner – and in Australia non-existent. That means that if you pledge your securities to a broker (for a margin loan or even as collateral against a bill as low as $100) you can lose the lot in the event of a broker failure because the broker can repledge them to cover their own borrowings.

When Lehman failed the US broker-dealer sailed through unharmed. The UK broker dealer failed causing huge client losses and a huge panic. I blogged about that here and here.

Opes Prime was smaller than Lehman London but the characters were just as unsavory. I blogged about that here.

I have no problem with a broker-dealer using their own capital to run their business or to trade. I have a big problem with a broker dealer using their client capital to run their business. I suggested a fix to the Australian Government in a submission to the Cooper review – but alas this has disappeared into the do-nothing basket.

How long is it that Australia needs to hold itself up as a place where you can come, open a broker dealer, fund it with client money – and – in at least one case disappear with client money before the Australian Government will do something?

John

PS. There is a reflexive no-government-regulation thing amongst some of my readers. But the question here is not whether we should allow brokers such as Goldman to speculate. The question is whether we should allow them to speculate for their own profit with the clients’ money. Lehman US speculated itself into oblivion but it did not do it with client money and the clients of the broker dealer were made whole. Lehman UK speculated with client money speculating their clients into oblivion. In the Sonray case the clients were mostly retail.

21 comments:

Anonymous
said...

I am worried about 1)the cash I have with this brokerIs it not true that as per ASIC rules the broker has to keep client money in segregated account?Although it might be possible that each client does not get separate segregated account and all clients money is pulled in to one segregated account. SO in that sense the clients are not creditors and this money should be clearly visible?Is there any insurance coverage?2) All the positions were closed by force so can we take legal action because we have been denied the opportunity. and forced to close a positionCan anybody please elaborate along these lines

John, what do you expect from politicians? The toppling of the democratically elected Prime Minister Rudd has just demonstrated who really holds power in Australia. So much for democracy then. Surely the lack of regulation for brokers in Australia also works in favour of somebody who does not like to concede his advantage.

1. No insurance policy in Australia.. US has SIPC 500 thousand limit for securities 100 thosand - now 250 thousand for cash.2. No client segregation of securities but there is a segregated client account for cash... so you should get your cash back provided that there is no shortfall in the client segregated account.3. Liquidator will close all positions - those are not client segregated - so closure makes sense. Makes no difference - you cannot collect anyway as the positions are in the name of the broker.4. You can sue - but there is no capital left to sue so you will not recover.

My guess is that you are toast on positions and have some chance on the cash...

There is NO Australian broker I would ever pledge my shares to - none at all - and that includes JBWere/Goldman Sachs.

I would happily pledge to the US domiciled broker.

Here is the disclosure re segregated cash...

All money deposited into your account by you or by a person acting on your behalf, or which is received by Sonray onyour behalf, will be held by Sonray in one or more segregated accounts it must maintain pursuant to the CorporationsAct. Please note that individual client accounts are not separated from each other, but may be co-mingled into onesegregated account (which is separate to Sonray’s monies/assets). It is important to note that holding your money insuch segregated account may not afford you absolute protection, and the purpose of the segregated account is toseparate Client monies from Sonray monies. All Client monies are pooled together within the segregated account,therefore an individual Client’s balance may not be protected if there is a default by another Client that causes a lossto the overall segregated account balance. In order to minimise this risk, Sonray may use its own company funds tocover any Client balance shortfall that may be caused by a Client default in the short term. If there is a deficit in thesegregated account and in the unlikely event that Sonray becomes insolvent before it makes up the deficit in thesegregated account, then you will be an unsecured creditor of Sonray in relation to the balance of any monies owingto you from the segregated account.

Whilst the Client’s money andproperty is segregated from Sonray’smoney and property, it may be comingledwith the money andproperty of other Sonray clients, andutilised as free and clear collateral bySonray from time to time in respectof open positions. Such monies andproperty shall accordingly be treatedas the legal and beneficial propertyof Sonray, subject to an obligation bySonray to transfer equivalent back toClient in accordance with theirtransaction rights under these Termsand Conditions;

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Your collateral is treated as the beneficial property of Sonray - so to the extent you have property as collateral you look to be stuffed.

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It does not seem to suggest that it can use your property when it is not collateral...

Just to make it clear you lose collateral rights on positions there is this disclosure:

Sonray may use the funds in theclient segregated account to manageSonray’s dealings with itscounterparties with respect to clientpositions. The Client acknowledgesthat this serves as sufficient writtenauthorisation for Sonray to withdrawwithout notice to, or furtherauthorisation from, the Client anymoney or property deposited intothe segregated account to be usedby Sonray for this purpose. TheClient has no interest in or claim overSonray’s contracts (if any) with anyother person or in the accounts intowhich Sonray lodges or pays thefunds which were withdrawn fromthe segregated accounts. The Clientacknowledges that the balance ofthe Client’s account may not beprotected if there is a default in thedealings with counterparties or inthe overall segregated accountbalance;

As long as the shares wind up registered IN YOUR OWN NAME you can use almost anyone to open an Aussie brokerage account.

Comsec is fine. NOLT is fine.

I would prefer one with the major banks because it is then funded out of an aussie bank account.

Margin accounts are generally awful in Australia because they allow pledging of your securities even if you just OPEN the margin account - and don't use it.

There are some exceptions - there used to be a margin account funded by securitising the margin loans - but I have not seen it.

I would NOT use an Australian margin account at all. If you want to buy Aussie shares on margin then unless it is the one that funds by securitising the loans (and sorry I have forgotten which that was) use a US broker to do so. You will then have problems with franking credits.

But if you ever needed a reason for NOT buying Australian equities on margin this is it.

But then it is hard to justify buying a market this expensive on margin anyway.

Out of interest, why, in your view, are the politicians so reluctant to do anything about this? Is it that they don't understand the issue, is it that at present there is no public appetite to protect those losing their shirts (I'm writing from the UK where this attitude is common), or is there shadowy lobbying at work?

I only ask because I have never fully understood why rehypothecation of this sort isn't banned - it seems self evident that it serves no public good (only the private good of a lower cost of capital for the broker).

In the UK I think it was just deregulation gone crazy... there was a genuine (and we now know false) view amongst policy makers that people would not commit capital to entities with dodgy balance sheets - that was that the markets were the best regulators.

The situation now is that the regulator is totally deskilled - and would not know how to fix it if the thing popped out in front of them.

In Australia - I think it is deskilled generally.

There was a LOT of thought that went in the US 1934 Act. It was hard-won legislation done the way the US does thing when at its best. That doesn't mean I like all the legislation - but at least I get it...

Generally there are no votes in this stuff - and it requires disciplined and competent politicians to get this right. Those politicians - of all stripes - are thin on the ground - and there are LOT of issues that require that level of thought. This is not a unique situation...

(I do not now how to improve political processes - and ultimately that is the problem...)

Does this mean any cash ( forget margin shares CFD etc) held with any AFSL broker( Equity / FX/ CFD) can be at 100% riskEven if in a pooled segregated client account!And what on earth is a point of pooled segregated client account IF THE BROKER CAN use that money to cover its business failure? where caused by it's blow out of business expenses or because it allowed one/ group client to go on a huge Margin call?By the way in this model does sonray makes the market or Saxo ( which is an overseas entity?)I used to think ASIC regulation was much better then places like Cyprus and Malta or British Virgin islands but it seem AFSL is as dodgy as those form the smaller nations... ASIC = toothless dog

Thanks again for the education I only half understand these products but I get dont invest in them. I find the assumption of people that regulators in this country are capable from a government that couldn't manage to put pink batts in ceilings safely and a new idiot PM who thought the US education system was an example to us all and meaningless league tables were worth a big fight over. No not batting liberal, most of this failure to act happened under them, its amazing they didnt destroy the banks, probably just inertia. Thanks again.

After Sonray I started to read other FX brokers PDS and realized no matter where you go your in Australian FX / CFD borkers your money is at risk if broker goes out of business it can take your money with it.SO is there any broker in Australia who is better than this?Why can't the watchdog applies the same rule it applies to ASX participating brokers?As we speak Millions of $ are at risk

There is NO solution with Australian brokers. We simply do not regulate. The only solution is to hold equities directly and NEVER in the name of a nominee...

ALL CFD providers suck...

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But if you think that it is millions of dollars at risk you are wrong. It is billions - no tens of billions. Australia has its asset security wrong GENERALLY - be it superannuation, broking or insurance.

I am currently working on a short driven by asset security issues in Australia.

Somewhere along the line the legislation in the US that got asset security right was just skipped in Australia. This is a disaster in the making.

I have written to the government several times... it hardly helps and I am well connected in Canberra. The issues are hard...

Would love it if some enterprising journalist would take this up as a popular cause... but I have little hope on that...

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The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.